Proposed Regs. Would Clarify Who Is Subject to Sec. 274(n) Limit on Meal Expenses

The IRS released proposed regulations under Sec. 274
clarifying which party is subject to the rule under
Sec. 274(n)(1)(A) that limits the deduction for meals
to 50% of the expenses incurred (REG-101812-07).
As the IRS emphasized, only one party is intended to
be subject to the limitation, and there has been
controversy over who is subject to it when multiple
parties are involved.

Sec. 274(a) limits the amount of
food and entertainment expenses that are deductible,
and deductions for meals are generally limited to 50%
of the expenses incurred (Sec. 274(n)). Under Sec.
274(e)(2)(A), employers are not subject to the
limitation to the extent they treat the expenses as
compensation to the employees.

Sec. 274(e)(3) provides two exceptions from the
Sec. 274(a) limits for reimbursed expenses. Sec.
274(e)(3)(A) excepts expenses a taxpayer pays or
incurs in performing services for another person under
a reimbursement or other expense allowance arrangement
where the employer does not treat the reimbursement as
compensation to the employee. In that case, the
employee does not have additional compensation or a
deduction for the expense, but the employer deducts
the expense and is subject to the deduction limit. If
the employer treats the reimbursement as compensation,
the employee may be able to deduct the expense as an
employee business expense. In that case, the employee
bears the expense and is subject to the deduction
limit. The employer deducts the expense as
compensation, which is not subject to the deduction
limit under Sec. 274.

Sec. 274(e)(3)(B) applies
if the taxpayer performs services for a person other
than an employer and the taxpayer accounts
(substantiates, as required by Sec. 274(d)) to that
person. The Eighth Circuit applied this subsection in
the Transport Labor case. In that case, the
taxpayer, a leasing company that provided truck
drivers to its clients, charged the clients for the
wages and the per diem allowance it paid the truckers.
Because the taxpayer provided services to its clients
under a reimbursement or other expense allowance
arrangement and accounted to the clients, it qualified
under Sec. 274(e)(3)(B) for the exception from the
Sec. 274(n) limit with respect to the per diem expense
and instead the clients were subject to the limit.

The proposed regulations set out a new definition
of reimbursement or other expense allowance
arrangement for purposes of Sec. 274(e)(3). This
definition is independent of the definition for
accountable plan purposes in Sec. 62(c). The proposed
regulations also clarify that the rules for applying
the exceptions to the Secs. 274(a) and (n) deduction
limits apply to reimbursement or other expense
allowance arrangements with employees, whether or not
a payor is an employer. Any party that reimburses an
employee is a payor and bears the expense if the
payment is not treated as compensation and wages to
the employee.

The regulations also permit
taxpayers involved in multiparty arrangements
involving nonemployees (i.e., independent contractors)
to provide by agreement who will be subject to the 50%
limit. Absent an agreement, the limit will apply to an
independent contractor if he or she does not account
for the expense under Sec. 274(d), and to the client
or customer if the independent contractor meets the
substantiation requirements.

The proposed
regulations include an example illustrating how the
rules apply to multiparty reimbursement arrangements,
such as the one found in Transport Labor.
Multiparty reimbursement arrangements are separately
analyzed as a series of two-party reimbursement
arrangements.

The proposed regulations will be
effective on the date they are published as final in
the Federal Register. However, taxpayers may
apply these regulations to tax years beginning before
the effective date for which the limitation period
under Sec. 6511 has not expired.

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